A blawg containing a periodic review of topics of interest in corporate and commercial law that impact India

Wednesday, December 31, 2014

Derivative Action for Patent Infringement Disallowed

Spicy IP has a post
discussing a judgment of the Bombay High Court in Darius
Rutton Kavasmaneck v. Gharda Chemicals Limited, which involves a
derivative claim by a shareholder of a company that traverses issues of company
law and patent law. In disallowing the claim, the Bombay High Court dealt with
issues pertaining to derivative actions and clarified circumstances where they
would be allowed to proceed. Those circumstances were found not to exist in
this case.

Facts and Ruling

The plaintiff was
a shareholder holding 12% of the 1st defendant, Gharda Chemicals Limited. The
principal claim lay against the 2nd defendant, Keki Hormusji Gherda,
who is the chairman and managing director (CMD) of the company. The plaintiff
shareholder alleged that the CMD applied for and/or obtained several patents in
his own name, while those patents ought to belong to the company. Since the
actions allegedly amounted a breach of fiduciary duties owed by the CMD to the
company, the plaintiff argued that he was entitled to bring a derivative claim
on behalf of the company since he was a minority shareholder. In terms of
relief, the plaintiff sought an injunction against the CMD in relation to the
utilization of the patents.

The Court began by
treating this action as a representative suit as it was brought by a
shareholder on behalf of the company. This principle has now been well-established
in India, and the court was merely complying with accepted precedents. Although
courts generally deal with such suits in terms of Order 1 Rule 8 of the Civil
Procedure Code, 1908, in this case the judgment does not make any express
reference to that provision or interpret it.

Given that
derivative actions in India are essentially a matter of common law, the Court
relied on English precedents, principally Smith
v. Croft [1998] Ch. 114. In that case, a derivative claim was disallowed
because the body of independent shareholders of the company were not supportive
of the derivative claim. In other words, the court placed significance on the
will of the majority of independent shareholders. The Bombay High Court relied
on Smith v. Croft in disallowing the
derivative claim in the present case as well. It was found that the plaintiff’s
siblings who held 13% shares between them were against the present litigation,
and effectively sided along with the defendant CMD. The fact that the plaintiff
was only in the minority among the independent shareholders in bring the suit
weighed heavily with the Court in arriving at its conclusion.

The Court further
supported its conclusion by having regard to the conduct of the plaintiff. This
approach is consistent with the requirement that any plaintiff shareholder in a
derivative action must approach the court “with clean hands”. In the present
case, the Court considered several circumstances that suggested the plaintiff
had not met with this requirement. The plaintiff had initiated several rounds
of litigation before different fora against the defendants, and that too
unsuccessfully, and this action was in similar vein. Moreover, it was found that
the plaintiff had not only commenced a competing business, but was also
intending to transfer his shares in the company to another competitor. All of
these further demonstrated the lack of bona
fides on the plaintiff’s part in bringing the claim.

Finally, the Court
made certain observations which indicate the unsatisfactory nature of the law
relating to shareholder derivative actions in India:

The
Courts should be alert in dealing with such speculative suits and shoot down
such bogus litigation at an early stage. This action on the Plaintiff, it is
quite obvious is inspired by vexatious motives. I observe with regret the
infliction of the ordeal upon the Courts by parties like the Plaintiff by
presenting a case which was disingenuous or worse. It may be a valuable
contribution to the cause of justice if such speculative and frivolous litigations
are dealt with a tough hand. Substantial judicial time will be saved if such
parties are saddled with substantial costs so that they would not continue the
onslaught on precious judicial time.

The Court also
directed the plaintiff to pay a sum of Rs. 10 lakhs (Rs. 1 million) towards
costs.

Broader Implications

Given the facts of
the case, it would be hard to quarrel with the conclusion arrived at by the
Court or its reasoning. But, the context and approach permit us to draw some
broader inferences.

Shareholder
derivative actions are rare in India. As a co-author and I found, “[o]ver the
last sixty years only about ten derivative actions have reached the high courts
or the Supreme Court. Of these, only three were allowed to be pursued by
shareholders, and others were dismissed on various grounds.”[1] A
number of reasons can be attributed to this result. Primary among them is the
fact that shareholder derivative actions in India are still ensconced in common
law. Indian courts rely heavily on English precedent, as the Bombay High Court
did in the present case. The problem with this approach is that cases may be
decided largely on the facts, with broader legal principles (that can be
applied across situations) being rather elusive. For example, the application
of the “clean hands” doctrine arises essentially as a matter of common law. It
is a different matter that the English Companies Act of 2006 (and several other
jurisdictions within the Commonwealth) have transitioned to a statutory form of
derivative action where the legislation expressly recognises such actions and
also prescribes the more specific circumstances where they can be allowed. India
has, however, not chosen to adopt the statutory form. Unfortunately, the
deliberations leading up to the enactment of the Companies Act, 2013 are silent
regarding the reason for this approach. It is not clear whether the lack of
statutory recognition for derivative actions is a conscious choice, or a mere
oversight. This result will continue to permit a fact-based determination steeped in common law, as the Bombay High Court has engaged in this case.

While the lack of the
statutory form of derivative actions may be a dampener on such claims, other
circumstances may add to that as well. Delays in the Indian judicial system,
exorbitant costs of bringing civil suits, and the lack of contingency fees
(that usually motivate plaintiff law firms) all lead to the minimal utilization
of shareholder derivative suits in the Indian context. A different position may
ensue upon the effectiveness of the provisions relating to “class action” suits
under the Companies Act, 2013, but it is not clear whether that mechanism is
intended to address derivative actions. While that mechanism could be wide enough
to encompass derivative actions, the provisions do not expressly cover the
scope and conditions for invocation of derivative actions. Until some statutory
recognition is conferred upon derivative claims, courts in India would continue
to treat derivative actions in the same manner as the Bombay High Court had to in
the instant case, i.e. a fact-based determination using principles of common
law.

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